ANNUAL REPORT

Transcription

1 ANNUAL REPORT

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3 CEO S MESSAGE As the newly appointed CEO of Merchants Bank, I see a great future for our organization. A future focused on serving the needs of our customers and communities in our immediate market with expanded products and services. A focus on controlling expenses while building earning assets to achieve an acceptable bottom-line that places us in the upper tier of our peers. A focus to ultimately achieve a sustainable, long-term profitable growth and required levels of capital and shareholder value. A focus to make Merchants Bank one of the best places for our employees to work in our industry. This would not be possible without the guidance of our Board of Directors, a strong management team and a dedicated, hardworking staff committed to serving the needs of our customers and exceeding our customer expectations each and every day. We are actively engaged in strengthening and energizing the communities and organizations we serve through contributions, sponsorships and employee participation in many volunteer efforts throughout our region. It is our ultimate goal to help all of our loyal customers and neighbors bank. and live in a better place. Rocco A. Del Vecchio V. Daniel Smoker MANAGEMENT S MESSAGE As we begin a new year, we are confident that the changes in executive management and new additions to the board of directors will bring new opportunities for both retail and business relationships, which is expected to drive improvement in our financial performance in Loan growth finished strong in the fourth quarter, setting the stage for improved net interest income performance in future periods. The significant improvement in credit quality during 2016 is also expected to add to performance as resources are re-allocated to revenue producing activities. This will allow the Company to improve its efficiency ratio through growth in revenue while controlling its operating expenses. The results of the presidential election in November 2016 has already had a dramatic effect on the financial markets and economic forecasts. Bankers in particular are cautiously optimistic about the prospects for lower taxes, lighter regulatory compliance burdens, and more spending by consumers and businesses. Larry G. Rice, Jr. On behalf of everyone at Merchants Bank, we would like to thank our shareholders, customers and the community for your continued support. We look forward to a successful 2017 as we continue to serve the needs of the local communities in which we operate. Rocco A. Del Vecchio CEO V. Daniel Smoker CFO Larry G. Rice, Jr. CCO

4 Martins Creek Banks (Slate Belt) Weona Park Clock (Pen Argyl) DIRECTOR S MESSAGE Development of a Sound Future In 2016, The Board of Directors focused on a culture of change without disruption to the primary mission of providing the utmost in customer experience. New appointments to the board of directors and executive management helped frame the focus in the latter half of the year and for the future. David J. Jordan, Jr., Esq., partner with McFall Layman & Jordan in Bangor, was appointed to the position of Vice Chairman. Two additional directors joined the Board in July Paul B. Oberbeck, President/CEO of National Magnetics Group, Inc. in Bethlehem, Pa. and James J. Palmeri, Principal and co-founder of Shore Excursions of America and owner of Palmeri Funeral Home in Martins Creek, Pa. Our new Chief Executive Officer, Rocco A. Del Vecchio who brings more than 35 years of banking experience, also joined the Bank s Board of Director's in August. Larry G. Rice, Jr., who has been with Merchants Bank for 14 years, was named Senior Vice President / Chief Credit Officer in July. With new leadership in place, a Senior Executive Management Team made up of the CEO, Rocco A. Del Vecchio; SVP/CFO, V. Daniel Smoker; and SVP/CCO, Larry G. Rice, Jr., was formed to collectively enhance the Bank s daily operations. The first issues addressed were recognizing a fundamental need to realign resources and develop new strategies/structures to facilitate market growth. At the same time, tremendous progress was also made in expense reduction. S upport for Our Greatest Assets One of our greatest assets are our employees. Strides were made to build better communication among staff members, nurture employee growth through training, and recognizing employees who execute our mission of premier customer experience. A new recognition program called Making a Difference recognizes employees 4

5 gyl) who rise above expectations. Our employees remain committed to delivering our vision of exemplary community engagement and customer service. for an Ever-Changing Community Support Since 1890, Merchants Bank recognizes the important role in the development and societies of our surrounding communities. We remain committed to supporting the needs of the communities and customers throughout Northampton County. We believe that fundamental growth begins with the stability and well-being of the local community. Our involvement is woven into the framework of our company culture. Highlights: Our employees devotion resulted in 1,158 volunteer hours in community events, serving at soup kitchens, supporting non-profit organization fundraising efforts, and more. Local non-profits contributions, including Earned Income Tax Credit (EITC), amounted to $132,695 to 203 non-profit and community organizations Northampton Street Bridge (Easton) E nhancement of Customer Experience While our nine branches and friendly, experienced, staff provide the personal attention customers expect, Merchants Bank offers customers online banking options for the convenience of banking from home, office, or on the go. Our latest addition is the Business Mobile platform allowing business owners the flexibility of banking anywhere they choose through a smartphone or tablet. As we move through the next year, we turn our attention to launching a new website and Online Banking platform. In addition, we will introduce Android and Samsung Pay payment options for consumers. Richard M. Hotchkiss Chairman Historic Bethlehem Water Works (Bethlehem) Historic Whitefield House (Nazareth) 5

6 FINANCIAL HIGHLIGHTS (Dollars in thousands, except per share data) Selected Financial Condition Data: Total assets $372,759 $340,892 $352,596 $351,625 $322,503 Net loans 212, , , , ,708 Deposits 312, , , , ,438 Stockholders equity 29,573 29,241 28,622 26,479 28,021 Book value per share Selected Operations Data: Net income $1,736 $1,771 $1,785 $1,595 $1,643 Earnings per share Dividends per share Net interest income 10,554 10,263 10,065 9,863 9,655 Loan loss provision Noninterest income 1,609 1,716 1,768 1,679 1,708 Noninterest expense 9,944 9,645 9,520 9,358 8,798 Other Selected Data: Return on average assets 0.49% 0.50% 0.51% 0.49% 0.53% Return on average equity Net interest margin (tax equivalent) Equity to assets Allowance for loan losses to loans Net charge-offs to average loans

7 P erformance MNB Corporation s (the Company) net income for 2016 was $1,736,000, a decrease of $35,000 or 2.0% from net income of $1,771,000 in The decrease is due solely to a onetime pre-tax valuation allowance adjustment in the amount of $354,000 for property held in its Other Real Estate portfolio. Exclusive of this onetime adjustment, net income would have been $1,969,000, an 11.2% increase. Strong deposit growth, record levels of loan originations, and expense control helped to drive performance, particularly in the second half of the year. As a result, the Company s return on average assets was modestly lower at 0.49% compared to 0.50% in Return on average equity decreased to 5.76%, down from 6.04% in Annual earnings per share was $1.53 compared to $1.56 earned in 2015, a decrease of $.03. Book value per share increased to $26.10 at December 31, 2016 compared to $25.81 at the end of Growth in book value was derived from growth in retained earnings partially offset by an increase in unrealized losses in the market value of available-for-sale investments. Total net loans increased by $20.3 million during 2016 with $15.0 million coming from the commercial sector. Loan growth was funded entirely by the exceptional growth in deposits totaling $28.4 million. A significant portion of the loan growth occurred in the fourth quarter, which led to average net loans outstanding increasing by $6.6 million to $199.8 million for 2016 compared to $193.2 million in Growth in average loans was funded by a combination of deposits and borrowed funds. Early in 2016, the Company was able to acquire very attractive wholesale funding from the Federal Home Loan Bank of Pittsburgh under their Community Lending Program, in which member banks can borrow at fixed-rate terms at the Federal Home Loan Bank s market cost of funds. This source of funding helped to contain the Company s cost of funds and offset Thousands $ Thousands $ 250, , , ,000 50, % 0.50% 0.25% 0.00% , , , ,000 $ 175, % 0.49% Return on Average Assets 0.51% 0.50% 0.49% $24.73 $23.37 Book Value Per Share $25.26 $25.81 $ Total Loans * $ 183,270 $ 190,063 $ 193,483 $213, *Before Allowance for Loan Losses Residential 1-4 Family Commercial Real Estate Commercial & Industrial Consumer Deposits $272,438 $306,321 $298,466 $312,672 $284, Checking Savings MMA CDs 7

8 the downward pressure in margins that the financial industry is experiencing due to a prolonged period of historically low interest rates. Commercial loans were also the primary source of growth in average loans outstanding in 2016 with the remainder concentrated in the residential mortgage sector. The Company continued to focus on growing core banking relationships in 2016, while reducing its reliance on certificates of deposit and municipal balances which are much more sensitive to market rates. Total assets were $31.9 million higher at December 31, 2016, compared to the same period in This growth in assets was primarily due to loan growth mentioned above, along with a $14.1 million increase in investment securities. On an average balance basis, total assets increased from $351.3 million in 2015 to $358.3 million in As expected, the Federal Reserve increased short rates by 0.25% in mid-december. Financial institutions immediately increased their prime lending rate, which affects variable rate loans, but did not materially change deposit rates as they tend to lag the market when it comes to deposit pricing. Merchants Bank also increased its prime rate as it typically follows Wall Street Journal Prime for pricing purposes. This change contributed to a minimal increase in our margin for the month of December but did not materially affect the results for the full year. The Federal Reserve also gave notice of their expectations for three additional rate hikes in 2017, which was a change from their previous forecast for two hikes in After sliding for most of the year, both business confidence and consumer confidence jumped after the election. There may not have been a direct correlation, however Merchants Bank experienced solid loan demand in the last two months of the year. And for the full year, new loan originations totaled $70 million with net outstanding loans surpassing $200 million for the first time in the bank s history. In addition to the $15.0 million growth Net Interest Margin in commercial loans noted above, Merchants realized solid demand for consumer loans in 5.00% 2017, primarily one-to-four family residential and home equity mortgage loans. 4.25% The tax equivalent net interest margin held steady at 3.30% in The yield on earning assets dropped to 3.59% versus 3.60% in 2015 with the rate on interest-related liabilities rising slightly to.38% in 2016 versus.37% in The yield on loans was under continual pressure due to the low rate environment for most of the year. However, Merchants Bank was able to offset this for the most part by re-investing investment cash flows at higher rates. The average rate on interest bearing liabilities increased primarily due to wholesale funding obtained from the Federal Home Loan Bank of Pittsburgh mentioned previously. A larger percentage of earning assets were funded with non-interest bearing deposits in 2016, ultimately helping Merchants Bank maintain a stable net interest margin. Thousands $ 3.50% 2.75% 2.00% 12,000 8,000 4, % 3.43% 3.22% 3.30% 3.30% Net Interest Income* $9,655 $9,863 $10,065 $10,263 $10, *Non-tax equivalent 8

9 Non-interest income was down in 2016, Annual Operating Costs decreasing by $107,000 to $1,609,000 compared to $1,716,000 reported in This decrease 12,000 $9,944 is primarily due to a reduction in number and $8,798 $9,358 $9,520 $9,645 volume of residential mortgage loans originated 9,000 with the intent to sell into the secondary market. Accordingly, a greater percentage of residential 6,000 mortgage loans were added to the loan portfolio 3,000 compared to the prior year which contributed to the loan growth discussed earlier. Branch 0 service charges, particularly fees from electronic banking services, increased by $37,000, or 6.3%. Revenue from the sale of foreclosed assets dropped as a result of fewer properties acquired through foreclosure actions. Net gains on sale of securities were $129,000 in 2016 compared to $121,000 in Thousands $ Non-interest expenses increased from $9,645,000 in 2015 to $9,944,000 for the year ended December 31, 2016, an increase of $299,000 or 3.1%. Excluding the $354,000 one-time loss in Other Real Estate Owned, operating expenses would have been $9,590,000, a decrease of $55,000. Categories where cost savings were achieved included occupancy and equipment expenses and FDIC insurance premiums. Occupancy and equipment expenses dropped by $42,000, primarily as a result of leasing office space to third parties, which contributed $38,000 of the cost savings. FDIC insurance premiums dropped by $50,000 due to regulations requiring the FDIC to reduce bank assessments once the reserve ratio reaches 1.15%, a level that was surpassed on June 30, Salaries and benefits were up slightly due to increased payroll taxes and health insurance premiums. Other cost increases occurred in Pennsylvania shares taxes paid and general administrative expenses. Management is always looking to improve our operating efficiency by reducing costs or limiting increases when appropriate. A renewed effort was initiated in the second half of 2016 upon the arrival of Chief Executive Officer Rocco Del Vecchio in the third quarter. The Company is also committed to making new investments in technology and services in order to help our customers effectively manage their businesses and personal finances. Asset Quality Credit quality in the loan portfolio continued to improve during the year as loans delinquent greater than thirty days dropped to 1.16% of total loans outstanding as of December 31, 2016, compared to 1.47% at December 31, The provision for loan losses was $185,000 in 2016 versus $180,000 in 2015, primarily due to net charge-off of loan balances totaling $157,000, and growth in the commercial portfolio. Nonaccrual loans were $1,902,000 at December 31, 2016, down from $2,446,000 at the end of 2015, a reduction of $544,000 or 22.2%. Loan charge-offs, net of recoveries, decreased to $157,000 in 2016, or 0.08% of average loans, compared to $661,000 in Non-performing loans as a percentage of total loans decreased to 0.89% compared to 1.26% at year-end Non-performing assets as a percentage of total loans and foreclosed assets decreased to 1.23% at December 31, 2016 compared to 2.00% at yearend As a result of improved credit quality, net charge-offs mentioned above, and strong growth in commercial loans, the Company s allowance for loan losses to total loans decreased to 0.86% at year-end 2016 compared to 0.94% in Other real estate assets totaled $737,000 at December 31, 2016, compared to $1,459,000 at the end of 2015, a 49.5% decrease. This change was due to the disposition of multiple properties acquired through foreclosure action in 2015, and the $354,000 end-of-year valuation adjustment mentioned earlier. 9

10 Capital Management The Company is committed to maintaining a healthy capital base while maintaining the regulatory defined well-capitalized designation. As of December 31, 2016, Merchants Bank, the Company s wholly owned subsidiary, reported the following regulatory capital ratios: Tier I leverage ratio of 8.44%; Common equity tier 1 and Tier 1 risk-based capital ratios of 13.31%; and a Total risk-based capital ratio of 14.10%. All ratios remain well above the regulatory minimum ratios of 5%, 6.5%, 8% and 10%, respectively, for a wellcapitalized financial institution. Thousands $ 40,000 30,000 20,000 10,000 0 Stockholders' Equity $28,021 $26,479 $28,622 $29,241 $29, The Company maintained its quarterly dividend at $.18 per share during Total dividends were $.72 in 2016 versus $.82 in The company elected to forego the special dividend of $.10 paid in the fourth quarter of 2015 in order to preserve capital for future growth purposes. The Company s Board of Directors is committed to the active management of its capital and, as shareholders, fully understands how important the dividend policy is to our shareholders. The Board of Directors will continue to evaluate this policy on a regular basis and, when possible, look to reward shareholders while maintaining a sufficient level of capital to retain the well-capitalized designation. 10

11 FINANCIAL TABLE OF CONTENTS PAGE INDEPENDENT AUDITOR S REPORT 12 CONSOLIDATED FINANCIAL STATEMENTS: BALANCE SHEET 13 STATEMENT OF INCOME 14 STATEMENT OF COMPREHENSIVE INCOME 15 STATEMENT OF SHAREHOLDERS EQUITY 16 STATEMENT OF CASH FLOWS 17 NOTES TO FINANCIAL STATEMENTS 18 11

12 Board of Directors and Shareholders MNB Corporation INDEPENDENT AUDITORS REPORT We have audited the accompanying consolidated financial statements of MNB Corporation and its subsidiary, which comprise the consolidated balance sheet as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders equity and cash flows for the years then ended, and the related notes to the consolidated financial statements. MANAGEMENT S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. AUDITORS RESPONSIBILITY Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. OPINION In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MNB Corporation and its subsidiary as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Wilkes-Barre, Pennsylvania March 1,

13 MNB CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEET DECEMBER 31, 2016 AND 2015 (dollars in thousands, except per share data) ASSETS: Cash and cash equivalents $ 3,884 $ 3,277 Interest-bearing deposits in banks 461 3,305 Investments: Securities held-to-maturity 21,091 20,580 Securities available-for-sale 113,341 99,733 Total investment securities 134, ,313 Restricted equity securities 1, Loans held for sale Loans 213, ,483 Allowance for loan losses (1,839) (1,811) Net loans 212, ,672 Premises and equipment, net 7,914 8,248 Accrued interest receivable 1, Cash surrender value of bank owned life insurance 8,779 8,574 Foreclosed assets 737 1,459 Other assets 2,077 1,674 TOTAL $ 372,759 $ 340,892 LIABILITIES: Deposits: Interest-bearing $ 271,578 $ 252,270 Noninterest-bearing 41,094 32,023 Total deposits 312, ,293 Securities sold under agreements to repurchase 9,294 12,984 Federal Home Loan Bank short-term borrowings 5,600 2,700 Federal Home Loan Bank long-term borrowings 14,065 10,150 Accrued interest payable Other liabilities 1,395 1,390 Total liabilities 343, ,651 SHAREHOLDERS' EQUITY: Common stock, $.125 par value; 1,156,247 shares issued Additional paid-in capital 7,596 7,596 Retained earnings 24,275 23,354 Treasury stock at cost, 23,374 shares (682) (682) Accumulated other comprehensive loss (1,761) (1,172) Total shareholders' equity 29,573 29,241 TOTAL $ 372,759 $ 340,892 See Notes to Consolidated Financial Statements 13

14 MNB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 (dollars in thousands, except per share data) INTEREST AND DIVIDEND INCOME: Interest and fees on loans $ 8,860 $ 8,722 Interest and fees on loans held for sale 6 8 Interest and dividends on investments: Taxable 1,932 1,777 Tax-exempt Dividends Other Total interest and dividend income 11,536 11,243 INTEREST EXPENSE: Deposits Borrowed funds Total interest expense NET INTEREST INCOME 10,554 10,263 PROVISION FOR LOAN LOSSES NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,369 10,083 NONINTEREST INCOME: Service charges on deposit accounts Other fees and income Earnings on bank-owned life insurance Gain (loss) on sales of: Loans Securities available-for-sale Foreclosed assets 7 54 Total noninterest income 1,609 1,716 NONINTEREST EXPENSE: Salaries and wages 4,205 4,242 Employee benefits 1,356 1,304 Occupancy and equipment 1,341 1,383 Data processing FDIC insurance Pennsylvania shares tax Foreclosed assets Other general and administrative 1,512 1,510 Total noninterest expense 9,944 9,645 INCOME BEFORE PROVISION FOR INCOME TAXES 2,034 2,154 PROVISION FOR INCOME TAXES NET INCOME $ 1,736 $ 1,771 EARNINGS PER SHARE $ 1.53 $ 1.56 See Notes to Consolidated Financial Statements 14

15 MNB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 (dollars in thousands) NET INCOME $ 1,736 $ 1,771 OTHER COMPREHENSIVE INCOME (LOSS): Unrealized losses on securities: Unrealized holding loss arising during the period (684) (876) Less reclassification adjustment for gains realized in net income (129) (121) Unrealized gain transferred from securities available-for-sale to securities held-to-maturity Amoritization of unrealized gain for securities available-for-sale transferred to securities held-to-maturity (151) (122) Net unrealized loss on securities (964) (372) Tax effect Unrealized loss on securities, net of tax (636) (246) Defined benefit pension plan: Actuarial loss arising during period (46) (84) Less amortization of net actuarial loss Net defined benefit pension plan Tax effect (25) (12) Defined benefit pension plan, net of tax Total other comprehensive loss (589) (223) TOTAL COMPREHENSIVE INCOME $ 1,147 $ 1,548 See Notes to Consolidated Financial Statements 15

16 MNB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 (dollars in thousands, except per share data) COMMON STOCK ADDITIONAL PAID-IN CAPITAL RETAINED EARNINGS TREASURY STOCK ACCUMULATED OTHER COMPREHENSIVE LOSS TOTAL BALANCE AT JANUARY 1, ,132,873 $ 145 $ 7,596 $ 22,512 $ (682) $ (949) $ 28,622 Net income 1,771 1,771 Other comprehensive loss (223) (223) Cash dividend ($0.82 per share) (929) (929) BALANCE AT DECEMBER 31, ,132, ,596 23,354 (682) (1,172) 29,241 Net income 1,736 1,736 Other comprehensive loss (589) (589) Cash dividend ($0.72 per share) (815) (815) BALANCE AT DECEMBER 31, ,132,873 $ 145 $ 7,596 $ 24,275 $ (682) $ (1,761) $ 29,573 * $.125 par value each; 200,000,000 shares authorized. 1,156,247 shares issued. See Notes to Consolidated Financial Statements 16

17 MNB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 (dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,736 $ 1,771 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses Net amortization of securities Gain on sale of available-for-sale securities (129) (121) Depreciation of premises and equipment Proceeds from sale of loans held for sale 2,615 6,305 Origination of loans held for sale (2,177) (6,348) Gain on sales of loans held for sale (78) (179) Provision for loss on foreclosed assets Gain on sales of foreclosed assets (7) (54) Deferred income tax expense Earnings on bank owned life insurance (205) (208) Net change in: Accrued interest receivable (282) 53 Accrued interest payable 26 (26) Other assets (139) 125 Other liabilities Net cash provided by operating activities 3,365 3,079 CASH FLOWS FROM INVESTING ACTIVITIES: Net change in interest-bearing deposits in banks 2,844 3,621 Proceeds from sales of securities available-for-sale 4,107 3,920 Proceeds from maturities/calls and principal repayments of securities available-for-sale 18,985 25,381 Proceeds from maturities/calls and principal repayments of securities held-to-maturity Purchase of securities available-for-sale (38,115) (17,670) Purchase of securities held-to-maturity (1,290) (1,519) Redemption of restricted equity securities 446 1,359 Purchase of restricted equity securities (625) (1,504) Net increase in loans (20,685) (4,912) Proceeds from sales of foreclosed assets Purchase of premises and equipment (130) (130) Net cash (used in) provided by investing activities (33,447) 9,352 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in noninterest-bearing deposits 9,071 1,019 Net decrease in interest-bearing deposits 19,308 (15,192) Net change in securities sold under agreements to repurchase (3,690) 1,163 Dividends paid (815) (929) Net increase in short-term borrowings 2,900 2,700 Proceeds from long-term borrowings 4,915 9,150 Repayment of long-term borrowings (1,000) (11,200) Net cash provided by (used in) financing activities 30,689 (13,289) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 607 (858) CASH AND CASH EQUIVALENTS, BEGINNING 3,277 4,135 CASH AND CASH EQUIVALENTS, ENDING $ 3,884 $ 3,277 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 956 $ 1,006 Income taxes $ 302 $ 306 Transfer of loans to foreclosed assets $ 168 $ 831 Transfer of securities available-for-sale to securities held to maturity $ - $ 19,706 See Notes to Consolidated Financial Statements 17

18 MNB CORPORATION AND SUBSIDIARY Notes To Consolidated Financial Statements 1 Nature Of Operations And Summary Of Significant Accounting Policies Principles Of Consolidation The consolidated financial statements include the accounts of MNB Corporation (the Holding Company ) and its wholly-owned subsidiary, Merchants Bank of Bangor (the Bank ) and its subsidiary, MNB Investment Corp. (collectively referred to as the Corporation ). All significant intercompany balances and transactions have been eliminated in consolidation. Nature Of Operations The Bank operates under a state charter and provides a broad array of banking services through its community offices in Bangor, Pennsylvania and the surrounding communities. As a state bank, the Bank is subject to regulations by the Commonwealth of Pennsylvania and the Federal Reserve Bank of Philadelphia. The Holding Company is subject to regulation by the Federal Reserve Bank of Philadelphia. Use Of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ( GAAP ) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, the valuation of investment securities, deferred tax assets and foreclosed assets, and the determination of other-than-temporary impairment of investment securities. In connection with the determination of the allowance for loan losses, management generally obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Corporation to recognize additional losses based on their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change. The Corporation s investment securities are comprised of a variety of financial instruments. The fair values and possible other-than-temporary impairment of these securities are subject to various risks including changes in the interest rate environment and general economic conditions. Due to the increased level of these risks and their potential impact on the fair values and the need to recognize other-than-temporary impairment of the securities, it is possible that the amounts reported in the accompanying consolidated financial statements could change. Significant Group Concentrations Of Credit Risk The Corporation grants real estate, commercial, industrial and consumer loans to customers primarily in Northampton County, Pennsylvania. Although the Corporation has a diversified loan portfolio, a substantial portion of its debtors abilities to honor their contracts is dependent on the economic conditions in the sector in which the Corporation operates. 18

19 Cash And Cash Equivalents For purposes of the consolidated statement of cash flows, cash and cash equivalents include, if applicable, cash and balances due from banks, federal funds sold and securities purchased under agreements to resell, all of which have original maturities of ninety days or less. Interest-Bearing Deposits In Banks Interest-bearing deposits in banks are carried at cost which approximates fair value. Investments Debt securities that management has the positive intent and ability to hold to maturity are classified as held-tomaturity and recorded at amortized cost. Securities not classified as held-to-maturity are classified as availablefor-sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The Corporation has no trading securities. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their costs that are deemed to be credit-related are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Declines in the fair value of available-for-sale securities that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis. The credit-related impairment is recognized in earnings and is the difference between a security s amortized cost basis and the present value of expected future cash flows discounted at the security s effective interest rate. For debt securities classified as held-to-maturity, the amount of noncredit-related impairment is recognized in other comprehensive income and accreted over the remaining life of the debt security as an increase in the carrying value of the security. Restricted Equity Securities Restricted equity securities consist of investments in the Federal Home Loan Bank of Pittsburgh ( FHLB ), the Federal Reserve Bank of Philadelphia and the Atlantic Community Bankers Bank. Investments in these entities are restricted and carried at cost. The Corporation, as a member of the FHLB system, is required to maintain an investment in capital stock of the FHLB. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. Management considers whether this investment is impaired based on the ultimate recoverability of the cost basis rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of the cost includes (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on the institutions and on the customer base of the FHLB, and (4) the liquidity of the FHLB. Management believes no impairment charge is necessary related to its investment in FHLB stock. 19

20 Cash Surrender Value Of Bank Owned Life Insurance The Corporation is the owner and primary beneficiary of life insurance policies on certain employees. The earnings on the policies are recognized as a component of other income. The policies can be liquidated, if necessary, with tax costs associated. However, the Corporation intends to hold these policies and, accordingly, the Corporation has not provided for deferred income taxes on the earnings from the increase in cash surrender value. Loans Held For Sale Loans held for sale, primarily consisting of fixed-rate residential mortgages, are valued at the lower of cost or fair value, determined on an aggregate basis. The Corporation retains no interest, including servicing rights, in loans sold. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for unearned income, the allowance for loan losses, and any unamortized deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. The loan portfolio is segmented into commercial, residential and consumer loans. Commercial loans consist of the following classes: commercial and industrial, commercial real estate (including multi-family of five or more units) and commercial construction. Residential loans include 1-4 family mortgage loans. Consumer loans include junior liens, home equity lines of credit, and personal installment loans. The segments of the Corporation s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. Common risk characteristics include loan type, collateral type and geographic location. For all classes of loans, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest is reversed against interest income. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to management s judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans is determined based on contractual due dates for loan payments. Allowance For Loan Losses The allowance for loan losses represents management s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may 20

21 affect the borrower s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, a specific allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis. The Corporation does not separately evaluate individual residential or consumer loans for impairment, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring. The estimated fair values of substantially all of the Corporation s impaired loans are measured based on the estimated fair value of the loan s collateral. For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate-secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts include estimated costs to sell the property. For loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower s financial statements, inventory reports, accounts receivable agings, equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. The general component covers pools of loans by loan class including loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate and consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates and expected loss given default derived from the Corporation s internal risk rating process for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include: 1. Lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices. 2. National, regional, and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans. 3. Nature and volume of the portfolio and terms of loans. 4. Experience, ability, and depth of lending management and staff. 21

22 5. Volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications. 6. Existence and effect of any concentrations of credit and changes in the level of such concentrations. Each factor is assigned a value to reflect improving, stable or declining conditions based on management s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation. The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial, residential and consumer loans. Credit quality risk ratings include regulatory classifications of pass, management attention, special mention, substandard, doubtful and loss. Loans classified as management attention have above average risk evidenced by a declining earnings trend, decreasing liquidity, and/or asset quality, increasing leverage and strained cash flow. Although payments are current, future developments may adversely affect future payment ability. Loans criticized as special mention have potential weaknesses that deserve management s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Corporation has a structured loan rating process encompassing both internal and external oversight. Generally, residential 1-4 family and consumer loans are included in the pass category unless on nonaccrual status at which time they are classified as substandard. The Corporation s commercial loan officers and credit administration are responsible for the timely and accurate risk rating of the commercial loans in their portfolio at origination and on an ongoing basis. An ongoing review of commercial loans is performed by the loan review officer. The Corporation also utilizes an external loan review consultant to conduct a loan review of its portfolio each year. The external consultant generally reviews all loan relationships exceeding a specified threshold. Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired. An unallocated component is maintained to cover uncertainties that could affect management s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. In addition, federal regulatory agencies, as an integral part of their examination process, periodically review the Corporation s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate. 22

23 Transfers Of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Premises And Equipment Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets which range from three to forty years. Foreclosed Assets Assets acquired through, or in lieu of, loan foreclosures are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses. Foreclosed assets include $100 thousand of residential real estate at December 31, At December 31, 2016, the recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process was $164 thousand. Income Taxes Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Corporation determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. The Corporation recognizes interest and penalties on income taxes as a component of income tax expense. Earnings Per Share Earnings per share is based on the weighted average number of shares of common stock outstanding and adjusted for stock dividends. The Corporation s basic and diluted earnings per share are the same since there are no dilutive shares of potential common stock outstanding. Treasury Stock Treasury stock is recorded at cost. The subsequent disposition or sale of the treasury stock is recorded using the average cost method. Advertising & Marketing Advertising and marketing is expensed as incurred and was $104 thousand in 2016 and $98 thousand in